2024 Defied Expectations - December Market Commentary

The 19th century author Balzac wrote that “our worst misfortunes never happen, and most miseries lie in anticipation.” This quote perfectly captures 2024, a year when worries over a “hard landing” recession, the U.S. election, and more buffeted market sentiment.

Yet, as we approach year end, the S&P 500 is near record levels, inflation is subsiding, the economy is growing, and the Fed is cutting interest rates. This is a reminder that worrying can lead investors to make decisions that may not serve their long-term interests.

If the past few years have been about extremes – the bear markets of 2020 and 2022, compared to the sharp rebounds in 2021, 2023, and 2024 – then 2025 should be about regaining balance.

History shows that those who can maintain a disciplined, long-term approach are better positioned to achieve financial success. This will only grow in importance as we enter a new year when stock market valuations are well above average, the path of interest rates is uncertain, and doubts about artificial intelligence are emerging. It's prudent to expect unforeseen events that concern investors.

Fortunately, the lessons of the past year can guide financial decisions in 2025 and beyond.

Financial Markets

As 2024 winds to a close, financial markets have delivered exceptional performance. The S&P 500 returned 29% through December 12th, the Dow Jones Industrial Average rose 16%, and the tech-heavy Nasdaq added 33%. Global markets also showed strength, with emerging markets increasing 12% and developed markets gaining 9%. Eight S&P 500 sectors achieved double-digit returns, driven by strong corporate profits and improved market sentiment.

The Economy

A year ago, investors worried about a “hard landing” as the Fed kept interest rates high to fight inflation. Instead, the economy grew in 2024, supported by strong consumer spending, with real GDP advancing at a 2.8% annualized rate in the third quarter. The Fed began cutting policy rates in September after months of speculation. So far, the Fed has lowered rates by 0.75%, with markets expecting three or four additional cuts in 2025.

The timing and magnitude of these rate cuts remain uncertain and will depend on economic data. Regardless, just as high rates slowed economic growth and rattled investors in 2022, lower rates stimulate the economy, supporting the overall business environment.

The rate of inflation has fallen back near pre-pandemic levels, though prices for many goods and services remain higher. As of November, the Consumer Price Index grew at a year-over-year rate of 2.6%. The labor market remains strong, with 28.6 million new jobs generated since the pandemic and low unemployment at 4.2%.

Moderating price pressures allowed the Federal Reserve to reduce policy rates for the first time since 2020, and markets anticipate three to four additional rate cuts by the end of 2025. While challenges persist, including diminishing pandemic-era savings and increasing debt levels, the economic outlook remains encouraging. Few investors expected such a positive scenario twelve months ago.

Vanguard notes in their recently published market outlook (link below) that the US economy is performing well, while European growth is stagnant, and China suffers from an ongoing real estate crisis. US Trade and immigration policy changes pose possible risks to growth, as tariffs could slow international trade, and restricting immigration could reduce the size of the US workforce. But we cannot be certain what policies will be implemented until the new administration is sworn in.

Link to article (copy/paste into browser):

https://corporate.vanguard.com/content/corporatesite/us/en/corp/vemo/beyond-landing-our-economic-outlook-2025.html

Investment Strategy

Large U.S. tech companies, particularly those driving artificial intelligence innovation, have captured investor interest - with the six largest companies representing 30% of the S&P 500. Corporate America's strength is driving stock market performance, with earnings growing 8.6% over the past twelve months to $236 per share for the S&P 500. Profitability is encouraging, but stock prices have risen more than earnings, pushing valuations to high levels relative to history.

The well-known price-earnings (PE) ratio measures stock prices relative to earnings. The current PE for the S&P 500, using 12-month forward earnings estimates, is 22.4 - well above the historical average of 15.7 and approaching the dot-com bubble peak of 24.5. This elevated valuation suggests that investors are paying a premium for future earnings.

The Cyclically Adjusted Price-Earnings (CAPE) ratio, developed by Yale economist Robert Shiller, provides a longer-term perspective by using 10-year average, inflation adjusted earnings. The current S&P 500 CAPE of 38 is significantly higher than the post-1990 average of 27.

Whatever metric used, US stocks appear expensive. High valuations have important implications for investors. By paying more today, future returns are likely to be lower, making portfolio diversification crucial. Investors should consider balancing stocks with other asset classes like bonds and international investments, where appropriate based on their risk appetite.

Thoughts for the Year Ahead

How can investors retain perspective as we enter the holidays and bring the year to a close? Here are some ideas:

• Work with your trusted Quotient advisor to build and follow a plan to meet your long-term goals.
• Maintain a disciplined perspective. The future rarely resembles the past, but history suggests markets can thrive across various government and economic environments.
• Avoiding reactive decisions based on short-term market fluctuations.  The stock market has posted strong returns in four of the last five years. Being prepared in advance for market volatility is always prudent.

2024 showed us markets can perform well in spite of investor anxiety. Markets have shown remarkable resilience, supported by economic growth, innovation, and positive trends across many asset classes. It’s important to celebrate these positive outcomes, while remaining vigilant and focused on the long-term.

Whatever 2025 brings, we will be there with you to help meet the challenges and opportunities that lie ahead.

Thank you for reading, and for your continued trust.